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Stern Educational TV, Inc., has decided to buy a new compute

Stern Educational TV, Inc., has decided to buy a new computer system with an expected life at three years at a cost of $200,000. The company can borrow $200,000 for three years at 12% annual interest or for one year at 10% annual interest.

a. How much would the firm save in interest over the three year life of the computer system if the one year loan is utilized, and the loan is rolled over (reborrowed) each year at the same 10% rate? Compare this to the 12%, three year loan.

b. What if interest rates on the 10% loan go up to 15% in the second year and 18% in the third year? What would be the total interest cost compared to the 12%, three year loan.

Solution Preview

a. $200,000 borrowed × 12% × 3 years =
$72,000 interest cost (long-term)

$200,000 borrowed × 10% × 3 ...

Solution Summary

Stern Educational TV, Inc., has decided to buy a new computer system with an expected life at three years at a cost of $200,000. The company can borrow $200,000 for three years at 12% annual interest or for one year at 10% annual interest.

a. How much would the firm save in interest over the three year life of the computer system if the one year loan is utilized, and the loan is rolled over (reborrowed) each year at the same 10% rate? Compare this to the 12%, three year loan.

b. What if interest rates on the 10% loan go up to 15% in the second year and 18% in the third year? What would be the total interest cost compared to the 12%, three year loan.

$2.19